3JM Company Inc.

Published Articles by David Balovich

Published in: Creditworthy News
Date: 2/22/99

This is the ninth installment in a continuing series on financial statement analysis.

The offset to assets is liabilities. Liabilities, from the word liable, represent the obligations that a firm has to outside creditors. Although there generally is no specific one-on-one matching of certain assets with certain liabilities, the assets taken as a whole represent the resources available to pay the firm's liabilities.

The most common liabilities are money owed to suppliers, employees, financial institutions, bondholders, and the government.

There are generally two basic types of liability - current and long term.

Current Liabilities

Current liabilities is anything that is due and payable within a twelve month period. This would include suppliers, current portion of long term date (due within twelve months), taxes owed the government and any accruals.

Long Term Liabilities

Long term liabilities is any debt that is owed for longer then twelve months. These would include debt owed to financial institutions that have a maturity date greater then one year, debt owed to bondholders, deferred compensation and any other debts that are due beyond a twelve month period.

Valuation of Liabilities

Valuation of liabilities dose not cause nearly as many problems as valuation of assets. With assets, we have the problem of how to value the property or equipment. With liabilities if we owe Richard forty dollars, it is not hard at all to determine what our liability is, it is forty dollars.

Contingent Liabilities

Contingent liabilities are those liabilities that may be owed by the firm but the payment depends on some action that determines the firm actually owes the money. The most common contingent liabilities are those that may result from a lawsuit or an audit.

If an airline has an accident it may be liable to its customers for payment resulting in death, injury and loss of personal belongings. That will be determined by the NTSB through its investigation. During that period the airline has a contingent liability. They are required by GAAP to report the contingency amount in their notes but they are not required to list the amount under liabilities on their balance sheet until it is determined that they are in fact liable (remember one of the accounting criteria when it comes to statement preparation is materiality).

One of the questions that should always be addressed when reviewing liabilities is: Are there any contingent liabilities? If there are these should be added to the liability section by the analyst.

I wish you well.

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